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Matt,

This question about taxes confuses even the most experienced of analysts, believe me. It is a complicated subject.

Here's what I do. As shown in the book, I start with the provision for taxes (income statement) and then add the investment in deferred taxes. Basically, this is deferred tax assets minus deferred tax liabilities. Investment in deferred tax assets is the same idea as investment in fixed or working capital, so a simple concept when you think of it that way.

Now you are right, your head can spin because you have the provision for taxes, cash taxes as shown at the bottom of the cash flow statement, defensive taxes as we calculated in paragraph 2, and enterprising taxes.

In my spreadsheet, I look at all four numbers. See, I want as much data about a firm's operations as possible. If you subscribe to Value Investor Insight (www.valueinvestorinsight.com), you will see an interesting idea from Legg Mason's Bill Miller. "Analytic philosophy," Miller says, "fosters a particular way of approaching problems and arguments -- looking at things from every different angle to see what you might be missing."

I endorse analytic philosophy and Value Investor Insight, which was co-founded by longtime Fool contributor Whitney Tilson.

So to wrap up with taxes, if you see large discrepancies between any of these four numbers, try to figure out why. If you can answer that question, you will have a better handle on a firm's operations than most of the other analysts. Also, since the numbers can spike in any given year, look at the trend over several years.



Hewitt
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